Balance of Payments (BOP)

STUDENT'S VERSION

INTRODUCTION

A recent issue of the Economist, lists the merchandise trade balance at $-645 billion. What does this mean? Since 1980, the flow of financial capital flows from the U.S. to the rest of the world has increased 20 times. What does this mean? In this lesson, you will learn how to record sales of goods and services and flows of financial capital on the balance of payments.

TASK

Here is the CEE Balance of Payments - BOP Worksheet dealing with the transactions for two countries, Alpha and Omega. Sort them into current account or capital account transactions, and calculate the current, capital, and balance of payments balances. When you are done, you will be able to explain why the balance of payments must equal zero. Next, you will learn what the balances mean. You are on your way to understanding international trade.

PROCESS

On your "BOP" worksheet, record the following transactions as a "Debit" or "Credit" and if it is in the current or capital account. After each transaction, your teacher will explain why it is what it is. You will have the opportunity to complete a balance of payments on your own. When you finish the worksheet, your teacher will have some questions to help you better understand the material.

CONCLUSION

A country keeps track of its spending just like an individual. When a country spends more than it makes, it runs a current account deficit. In order to run a deficit, the country must borrow the funds or sell something it owns. The borrowing of funds or selling of assents is recorded in the capital account. You have seen that the current account and the capital account are a reflection of each other. When one account is positive, the other is negative. If you are an accounting student, you can think of the current account as an income statement. The bottom line is the balance of the current account. Think of the balance of payments as double entry accounting to ensure that the balance of payments is always zero. Finally, since all countries trade with each other, the sum of all of the countries balance of payments must be equal to zero.

ASSESSMENT ACTIVITY

1. In 2000, net exports were $-375.7, net investment income was $-14.9 and net transfers were $-54.1. What was the balance of the current account? __________

2. In 2001, exports for the United States were $720.8 billion and imports were $-1,147.4 billion. How much is net exports? ________

3. In 1980, the United States had net exports of $-19.4 billion, investment income of $30.1 billion and transfer payments of $-8.2 billion. Did the U. S. have a current account surplus or deficit?

4. Circle one: If a country is running a current account deficit, the capital account must be a (deficit/surplus).

5. If Alpha buys stock in a corporation in Omega, which account, current or capital, would the transaction be recorded?

6. When Alpha imports cheese from Omega, how is the transaction recorded for Alpha. Is it a debit or a credit?

7. If Omega has a current account surplus of $100, Omega's capital account must equal ______.

8. How is the trade balance calculated?_________

9. Circle the answer that completes the state: Some residents of Alpha send money to charities in Omega. This transaction would be recorded as a debit to transfers (to the world/from the world).

10. TRUE or FALSE. Alpha has an underground market in illegal drugs. Because these activities are not reported on the balance of payments, the current and capital account would not balance.

EXTENSION ACTIVITY

What does it mean to say that a country has a negative current account balance? For a country to run a deficit in the current account, means that it is buying more than it is selling so it must borrow the funds from the rest of the world. A country that runs a deficit, will issue debt instruments like treasury bills to finance their current spending. A country might have to raise the domestic interest rate to attract foreign investment. Obtain a copy of the Economist or visit: www.economist.com/node/18682709?story_id=18682709. Interest rates are listed on the last page. Confirm that countries with the highest merchandise trade balance also have the highest interest rates. The merchandise trade balance is trade in goods only. (NOTE: correlation does not mean causation.)

Unions argue that the U.S. imports more than it exports because labor is cheaper in foreign countries like Vietnam, Mexico, or India. Discuss some reasons why labor is cheaper in foreign countries. Some reasons to consider are the ratio of capital/worker, productivity, level of education, or products produced.